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June 1st, 2013 |
“The idea staggered me. I remembered, of course, that the World’s Series had been fixed in 1919, but if I had thought of it at all I would have thought of it as a thing that merely happened, the end of some inevitable chain. It never occurred to me that one man could start to play with the faith of fifty million people-with the single mindedness of a burglar blowing a safe.”
—Nick Carraway in The Great Gatsby
F. Scott Fitzgerald’s The Great Gatsby is a time capsule of the 1920’s and a precursor of the 2000’s. The 1920’s were a prosperous period enabled by improved productivity and renewed confidence. The radio and television was invented (1920), rocket engines (1926) and the family car (1920) changed the daily lives of the average citizen. The era saw both the creation of great wealth and the glory of materialism. The elite class and the common working man invested heavily in a speculative stock market. From 1920 to 1929 stocks more than quadrupled in price. And then the bubble burst! The stock market fell from 1929 to 1932 losing nearly 90% of its value before recovering. The Bernard Baruch story illustrates the era: Bernard Baruch was a wealthy businessman who used to get his shoes shined every day by the same shoe shine boy. One morning the shoe shine boy was giving him stock tips. Baruch went to his office, called his broker, and said,” Sell it all! When shoe shine boys are giving stock tips, it’s time to get out.” When does the stock investor re-enter the market? Maybe Daisy can reawaken the animal spirits.
Consumer confidence rose in May to its highest level since 2007 and yet fear permeates the psyche of the stock investor. How long will it take for the consequences of the financial crash of 2008 to dissipate? The answer might be found in a never to be drafted analysis of the precariousness and fickleness of confidence. Most crashes, including the subprime spillover in 2007, the Long Term Capital Management debacle in 1998, the market plunge in 1987 and the Wall Street Crash of 1929, were preceded by a real estate bubble, high levels of debt, chronically large current account deficits, and signs of slowing economic activity. The markets have always recovered and the degree of trauma tends to establish the timetable. Is this time different and does the recovery signal improving confidence? Warren Buffett once advised that to be fearful when others are greedy and greedy when others are fearful. Being wrong is painful, and as the markets currently demonstrate, individual investors will withdraw from the markets to avoid additional anguish. Will investors return to the markets before or after risk has been repriced? The Dow is above 15,000 for the first time, the S&P 500 is hitting new records everyday.
The Federal Reserve of New York recently issued a report entitled, “Are Stocks Cheap? A Review of the Evidence.” The authors, after examining twenty nine investment models, concluded that the stock market is extremely cheap on a historical basis. The market evidence is based on an examination of the expected rate of return when the difference between the S&P 500 yield and the 10-year Treasury rate is sizeable. Despite the booming market and/or the New York Fed study, the investing public has not embraced the high stock returns. Over the last seven years, according to calculations by Bank of America Merrill Lynch, mutual fund investors worldwide have poured a net $1.1 trillion into bond funds, and taken $900 billion out of stock funds. So far in 2013, the investing public has invested significantly more into bond funds-$85.4 billion into bonds compared with only $73.2 billion into stocks, according to Investment Company Institute estimate. “Strange days have found us; strange days have tracked us down, they are going to destroy our casual joys; we shall go on playing or find a new town” The Doors. Memorial Day is a living monument to those who fought and those who died – a recognition of freedom’s cost.